Week 7-Information Asymmetry with Review 2

Week 7-Information Asymmetry with Review 2 - INFORMATION...

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2/14/11 INFORMATION ASYMMETRY Accy 201 Discussion – October 9, 2009
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2/14/11 Definition One party has more or better quality information than the other part in a contract Pre-contractual or post-contractual Increases cost of contracting
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2/14/11 Adverse Selection Pre-contractual Party with the information extends an offer that would be detrimental to the trading partner Insurance The Market for “Lemons”
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2/14/11 Moral Hazard Post-contractual Agent has the private information, makes a decision that does not maximize principal’s utility Principal v. Agent Bonuses: once you hit a certain threshold use ‘cookie jars’ or halt production Financial Institutions Bail Out Car Insurance
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2/14/11 Reducing Adverse Selection Screening and Self-selection Screening: offering a multitude of contracts Done by party with less information Self-selection: choose among the contracts Insurance Deductibles Signaling Party with more information moves first by taking an action that provides information to other party College degree, work-experience, extracurriculars
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2/14/11 Reducing Moral Hazard Monitoring Principal incurs a cost to observe the actions of the agent Observes agent to see what problems may arise in the contract Bonding Agent promises to compensate the principal in case the agent doesn’t follow through with the terms of the contract Agent incurs the cost to insure his/her actions
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This note was uploaded on 02/14/2011 for the course ECON 302 taught by Professor Avrin-rad during the Spring '09 term at University of Illinois, Urbana Champaign.

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Week 7-Information Asymmetry with Review 2 - INFORMATION...

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